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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

or

Commission file number: 1-11578

DISC, INC.

Registrant’s telephone number, including area code: (408) 934-7000

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Yes x No ¨  

     The number of shares outstanding of the registrant’s common stock as of July 31, 2002 was 4,817,617.

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PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

DISC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — The Company

  Basis of Presentation

     We have prepared the unaudited interim condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles pursuant to these rules and regulations. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial position, operating results and cash flows for the periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes for the years ended December 31, 2001 and 2000 included in our Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the fiscal year, which ends December 31, 2002, or for any other period.

     In March 2002, we have received a written commitment from our largest investor, MK GVD Fund, to provide the necessary resources to support the company’s operation through April 16, 2003. We believe this committed future investment will be sufficient to meet our operating requirements through April 16, 2003. However, we anticipate that we will continue to incur net losses for the foreseeable future. The ability to sustain our operations for a significant period after April 16, 2003 will depend on our ability to significantly increase sales or raise significant additional equity or debt financing on terms acceptable to us. There is no assurance that any of these conditions will be achieved. In particular, we expect to require increasing amounts of cash to finance our efforts to increase sales, which we plan to achieve by increasing selling efforts to large system integrators and OEMs, by hiring additional sales and sales support staff and by making evaluation units available. In addition, we intend to expand our current network of resellers. We may require cash to finance purchases of inventory to satisfy anticipated increased sales as our products achieve market acceptance. In addition, we expect that the continued integration of our acquisition of DISC GmbH and the support of its operations will require cash as well. If we incur greater expenditures than we anticipate in these or other matters, and we cannot raise funds at acceptable terms or at all, we may not be able to develop or enhance our products, take advantage of other opportunities or respond to competitive pressures or unanticipated requirements. As a consequence, if we are unable to generate sufficient revenues or raise funding as required, the operations and prospects of our company, and its ability to continue as a going concern and to achieve its intended business objectives, will be severely harmed.

  Basis of Consolidation

     The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated.

  Foreign Currency Translation

     The functional currency of the Company’s foreign subsidiaries is the local currency. Accordingly, the assets and liabilities of the Company’s foreign subsidiaries are translated into U.S. Dollars using the exchange rates in effect at the balance sheet date. Income and expense items are translated at average

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exchange rates for the period. Foreign currency translation adjustments are included in other comprehensive loss as a separate component of stockholders’ equity. Foreign currency transaction gains or losses were not material in any of the periods presented.

Note 2 — Balance Sheet Details

     Accounts receivable at June 30, 2002 and December 31, 2001 are presented net of an allowance for doubtful accounts of $245,000 and $275,000, respectively.

Note 3 — Related Party Transactions

     During the six months ended June 30, 2002, the Company sold and MK GVD Fund, the principal shareholder, purchased 2,252, 16,260, 6,667, 24,138, 14,706, 1,961, 5,864, 9,804, 10,067, 28,846, 28,090, 27,778, and 43,210 shares of convertible preferred stock, Series GG, HH, II, JJ, KK, LL, MM, NN, OO, PP, QQ, RR, and SS, respectively, and warrants under a formula set out in a March 1996 agreement for aggregate proceeds of $25,000, $200,000, $100,000, $350,000, $200,000, $30,000, $95,000, $150,000, $150,000, $300,000, $250,000, $200,000, and $350,000, respectively. The warrants allow the holder to purchase 5,630, 40,650, 16,666, 60,344, 36,764, 4,902, 14,660, 24,509, 25,167, 72,115, 70,224, 69,444 and 108,024 shares of common stock for an exercise price of $1.39, $1.54, $1.87, $1.81, $1.70, $1.91, $2.03, $1.91, $1.86, $1.30, $1.11, $0.90, and $1.01 per share, respectively. Under the agreement the number of shares of preferred stock was determined based on the lower of 85% of the closing bid price or the average closing price of the Company’s Common Stock for the five trading days ended three days prior to the issuance date, but not to exceed $2.50 per share as converted into common stock.

     The fair value of the warrants issued during the three months ended June 30, 2002, $472,000, was determined using a Black Scholes option pricing model with the following assumptions: volatility of 145%; risk free interest rates ranging from 4.15% to 4.94%; expected life of five years and no dividend yield. The fair value of the warrants is recorded in shareholders equity.

     A beneficial conversion feature is computed as the intrinsic value of the spread between the quoted market price of common stock and the conversion price multiplied by the number of common shares into which the preferred stock converts. This beneficial conversion feature is accounted for as a deemed dividend to the preferred stockholders and increases the net loss attributable to common shareholders.

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Note 4 — Comprehensive Loss

     A summary of comprehensive loss for the periods presented is as follow:

Note 5 — Recent Accounting Pronouncements

     In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which is effective for fiscal years beginning after March 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. The Company has adopted SFAS No. 142 effective January 1, 2002 and has determined that there was no impairment.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities’” (“SFAS 146”). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We will adopt SFAS 146 during the third quarter of this fiscal year. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS 146. The effect on adoption of SFAS 146 will change on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

Note 6 — Operating Segments

     The Company operates in one industry segment.

     The following is a summary of the Company’s revenue attributed to the geographic regions:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

  Results of Operations

     For the three and six months ended June 30, 2002, the company had sales of $3,174,000 and $5,827,000, respectively, compared to sales of $2,513,000 and $4,075,000, respectively, for the three and six months ended June 30, 2001. The increase was primarily related to our July 2001 acquisition of NSM Storage GmbH (which we subsequently renamed DISC GmbH). The general sales cycles for distribution of our products are similar to those of most businesses selling products designed for use as part of large systems, and range from three to six months for value added resellers and small system integrators and from one to two years for original equipment manufacturers, product integrators and large system integrators. Because our products are part of large systems, the sales cycles for our products vary significantly and are difficult to predict for any particular transaction. The long and often unpredictable sales cycles for our products complicate forecasting for operational planning and may cause net sales and operating results to vary significantly from quarter to quarter.

     Cost of sales, as a percentage of sales, decreased to 80% and 82%, respectively, for the three and six months ended June 30, 2002, as compared to 83% and 86% for the comparable 2001 period, primarily due to the addition of the NSM product line which has a lower per unit cost. Our relatively low gross margins reflect our low levels of net sales, which have resulted in unabsorbed manufacturing costs and high costs of materials due to the inability to achieve purchasing economies of scale. We expect that, if product sales increase significantly, costs of sales per unit of product will decrease because fixed manufacturing costs will be distributed over the larger sales volume, and material costs will decrease as the result of volume purchases. However, even with product sales increases, cost of sales per unit of product may not decrease significantly or at all because the magnitude of the sales increase may not be sufficient or because manufacturing, material and other costs may independently increase.

     For the three and six months ended June 30, 2002, research and development expenses were $647,000 and $1,257,000, respectively, compared to $416,000 and $788,000 for the comparable period of 2001. The increase for the three and six month periods ended June 30, 2002 as compared to the comparable periods of 2001 were primarily due to an increase in headcount in connection with the acquisition of DISC GmbH. We believe that research and development expenses will remain relatively constant in dollar amounts during the remainder of 2002.

     Marketing and sales expenses were $1,132,000 and $2,211,000, respectively, for the three and six months ended June 30, 2002 compared to $829,000 and $1,581,000 for the comparable period in 2001. The increase for the three and six month periods ended June 30, 2002 as compared to the comparable period in 2001 is primarily due to an increase in headcount and related marketing and sales expenses related to the acquisition of DISC GmbH. We believe that marketing and sales expenses will increase moderately in dollar amounts during the remainder of 2002 as we have added significant resources in marketing and business development to allow us to address new markets and expand our customer base, but decline as a percentage of sales in the long term.

     General and administrative expenses were $505,000 and $892,000, respectively, for the three and six months ended June 30, 2002 compared to $312,000 and $590,000 for the comparable period in 2001. The increase is primarily due to an increase in headcount in connection with the acquisition of DISC GmbH. General and administrative expenses are expected to remain relatively constant in dollar amounts during the remainder of 2002.

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     Intangible amortization of $191,000 and $381,000, respectively, for the three and six months ended June 30, 2002 consist of the amortization of acquired intangible assets. The July 2001 acquisition of DISC GmbH generated approximately $3,376,000 in identified intangibles, which are currently being amortized over periods ranging from four to six years. We expect amortization expense to be approximately $190,000 for each quarter during 2002. Amortization could be affected by other acquisitions or impairment of existing identified intangible assets in future periods.

     Interest and other expense were $88,000 and $151,000, respectively, for the three and six months ended June 30, 2002 as compared to $30,000 and $53,000, respectively, for the three and six months ended June 30, 2001. The increase is primarily due to the interest on the debt assumed from the acquisition of DISC GmbH.

     Notwithstanding the foregoing, we may incur significant, unexpected expenses as a result of attempts to respond to technological advances, increased competition, new product announcements and releases by our competitors, changes in the data storage market, market opportunities and other factors discussed below in “Factors That May Affect Future Operating Results and the Market Price of Our Stock.”

  Liquidity and Capital Resources

     Net cash used in operating activities for the six month period ended June 30, 2002 was $2,554,000 compared to $2,557,000 used for the comparable period in 2001. Net cash used in operating activities in 2002 primarily reflects a loss of $3,693,000 partially offset by a decrease in accounts receivable of $408,000, a decrease in inventory of $266,000 and depreciation and amortization of $584,000. Net cash used in operating activities in 2001 primarily reflects a loss of $2,428,000 and in increase in accounts receivable of $334,000.

     Net cash used in investing activities was $33,000 for the six months ended June 30, 2002 compared to $123,000 for the six months ended June 30, 2001 and primarily consisted of purchases of hardware.

     Net cash provided by financing activities was $1,905,000 for the six months ended June 30, 2002 compared to $3,188,000, provided for the six months ended June 30, 2001. Net cash provided in 2002 consisted primarily of $2,400,000 of net proceeds from the issuance of preferred stock offset by the repayment of $495,000 of debt. Net cash provided in 2001 consisted primarily of $2,450,000 of net proceeds from the issuance of preferred stock and a $732,000 increase in the borrowings under the company’s factoring agreement.

     We have a factoring agreement that allows us to borrow the lesser of $1,500,000 or 85% of eligible receivables. As of June 30, 2002 our outstanding balance under this agreement was $441,000. At December 31, 2001, March 31, 2002 and June 30, 2002 we were not in compliance with the tangible net assets covenant of the agreement. We have requested a waiver of the non-compliance and although a waiver has not been received, borrowings have continued under the agreement.

     At June 30, 2002, we had a cash balance of approximately $207,000. In addition, we have a written commitment from our largest investor, MK GVD Fund, to provide the necessary resources to support the company’s operation through April 16, 2003. We believe this committed future investment will be sufficient to meet our operating requirements through April 16, 2003. However, we anticipate that we will continue to incur net losses for the foreseeable future. The ability to sustain our operations for a significant period after April 16, 2003 will depend on our ability to significantly increase sales or raise significant additional equity or debt financing on terms acceptable to us. There is no assurance that any of these conditions will be achieved. In particular, we expect to require increasing amounts of cash to finance our efforts to increase

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sales, which we plan to achieve by increasing selling efforts to large system integrators and OEMs, by hiring additional sales and sales support staff and by making evaluation units available. In addition, we intend to expand our current network of resellers. We may require cash to finance purchases of inventory to satisfy anticipated increased sales as our products achieve market acceptance. In addition, we expect that the continued integration of our acquisition of DISC GmbH and the support of its operations will require cash as well. If we incur greater expenditures than we anticipate in these or other matters, and we cannot raise funds at acceptable terms or at all, we may not be able to develop or enhance our products, take advantage of other opportunities or respond to competitive pressures or unanticipated requirements. As a consequence, if we are unable to generate sufficient revenues or raise funding as required, the operations and prospects of our company, and its ability to continue as a going concern and to achieve its intended business objectives, will be severely harmed.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995

     This quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that these forward-looking statements are subject to the safe harbors created by those provisions. These forward-looking statements include statements relating to:

	•		future research and development projects;
	•		increasing our sales efforts and possible increases in sales;
	•		potential future decreases in costs of sales per unit;
	•		expected research and development, marketing and sales and general and administrative expenditures;
	•		expanding our sales channels;
	•		expected sales cycles;
	•		the need for, and availability of, additional financing; and
	•		actual and potential acquisitions and their effects on our financial position.

     The forward-looking statements included in this quarterly report on Form 10-Q are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on assumptions regarding our business, which involve judgments with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot assure that the results contemplated in forward-looking statements will be realized. In addition, our business and operations are subject to substantial risks which increase the uncertainty inherent in such forward-looking statements (see “Additional Factors that May Affect Future Operating Results and the Market Price of our Stock” starting on page 9 of our annual report on Form 10-K for the year ended December 31, 2001 and “Factors that May Affect Future Operating Results and the Market Price of our Stock” below). In light of the significant uncertainties inherent in the forward-looking

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information included in this quarterly report on Form 10-Q, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved.

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Factors That May Affect Future Operating Results and the Market Price of Our Stock

     Our future operating results, and stock price, may be affected by a number of factors, many of which are beyond our control. These factors include the following:

  Our inability to meet ongoing funding requirements could severely harm our operations and the prospects of our company.

     To date, we have not generated enough cash from operations to fund our business, and we anticipate that we will need to seek additional funding in the future in order to fund our operations. In the event we need to raise additional funds, we may not be able to do so on favorable terms, if at all. We have a firm commitment from our largest shareholder, MK GVD Fund, to continue to provide us with the necessary financial resources to support our operations through April 16, 2003. There can be no assurance that this shareholder, or any other investor, will be willing to make similar commitments in the future. There also can be no assurance that other funding sources will be available to us on a timely basis to fund our operations on terms acceptable to us, or at all. If we are unable to raise sufficient funding as required, the operations and prospects of our company, and its ability to continue as a going concern, will be severely harmed.

  We have a history of losses and we expect to incur future losses.

     We have experienced significant operating losses since our inception, and as of June 30, 2002 had an accumulated deficit of $39,947,000. We expect to continue to incur net losses for the foreseeable future, and our ability to sustain our operations for a significant period after December 31, 2002 will depend on our ability to significantly increase or even maintain sales or raise significant additional debt or equity financing. There can be no assurance we will be able to increase sales or that additional financing will be available on acceptable terms, or at all. Further, if we issue equity securities, shareholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of our existing securities. Even if we are able to increase sales, we may incur net losses for the foreseeable future due to anticipated spending increases primarily on sales, marketing and research and development efforts. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis.

  Our quarterly revenues and operating results may fluctuate for a number of reasons, which may cause our stock price to fluctuate.

     Our quarterly operating results have varied in the past and are likely to vary significantly in the future due to several factors, including:

	•		the size and timing of significant customer orders;
	•		shifts in product or distribution channel mix;
	•		increased competition and pricing pressure;
	•		timing of new product announcements and releases by us or our competitors;
	•		new product developments by storage device manufacturers;
	•		the rate of growth in the data storage market;

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	•		market acceptance of new and enhanced versions of our products;
	•		timing and levels of our sales and operating expenses;
	•		gain or loss of significant customers or distributors;
	•		changes in economic conditions;
	•		personnel changes; and
	•		our ability to effectively integrate the products and operations of NSM Storage GmbH with ours.

     Our quarterly revenue and operating results have been affected by seasonal trends. These trends often result in lower revenue in the first quarter of each fiscal year compared to the fourth quarter of the previous fiscal year due to customer purchasing and budgetary practices.

     The general sales cycles for distribution of our products are similar to those of most businesses selling products designed for use as part of large systems, and range from three to six months for value-added resellers, or VARs, and small system integrators and from one to two years for original equipment manufacturers, or OEMs, product integrators and large system integrators. Our variable and extended sales cycle makes it difficult to predict if or when revenue will be earned. Since our operating expenses are based on anticipated revenue levels and because a high percentage of these expenses are relatively fixed, a delay in a sale or revenue recognition for a sale could cause significant variations in our operating results from quarter to quarter and could cause unexpected results.

     Operating results in any period should not be considered indicative of the results investors can expect for any future period. Due to the forgoing and other factors related to our industry, past results are a much less reliable predicator of future results than is the case in many older, more stable and less dynamic industries. We cannot assure you that we will be able to increase or even sustain our recent levels of quarterly revenue and net sales, as normalized for unusual or one-time items, or that we will attain or maintain profitability in any future period. Any unfavorable change in the factors described above or any other factors could adversely affect our operating results for a particular quarter. In addition, it is likely that in some future quarters our operating results will be below the expectations of public market analysts and investors. In any of these events, the price of our common stock would likely decline.

  Because we operate with little backlog, our operating results could be adversely affected if we do not accurately anticipate future sales levels.

     Historically, we have operated with little order backlog and, due to the nature of our business, do not anticipate that we will have significant backlog in the future. Consequently, a large portion of our revenue in each quarter results from orders placed during that quarter. Because of the relatively large dollar size of orders from our distributors and OEMs, delay in the placing of a small number of orders by a small number of purchasers could negatively affect our operating results for a particular period. In addition, our operating expense levels are, in the short term, largely fixed and are based, in part, on expectations regarding future revenue. Thus, our operating results could be disproportionately affected if we do not receive the expected number of orders in a given quarter and our net sales falls below our expectations.

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  We depend on certain key suppliers and if we are unable to obtain adequate supplies, our sales and operating results could be significantly adversely affected.

     We do not possess proprietary optical disk, high-density disk or other storage technologies and, consequently, we depend on a limited number of third-party manufacturers to supply us with the devices that we incorporate into our products. In some cases, these manufacturers are sole-source providers of the device technology. Our suppliers have in the past been, and may in the future be, unable to meet our supply needs, including our needs for timely delivery, adequate quantity and high quality. We do not have long-term contracts with any of our significant suppliers. If these suppliers were to decide to pursue the disc library market directly, they may cease supplying us with disc drives and media, in which case we may be unable to obtain adequate supplies of disc drives and media at acceptable prices, if at all. The partial or complete loss of any of our suppliers could result in significant lost sales, added costs and production delays or may otherwise harm our business, financial condition, operating results and customer relationships.

  We have a concentrated customer base, and therefore the loss of a single customer could negatively affect our operating results.

     The majority of our end users purchase our products from distributors, VARs, OEMs and systems integrators. We have no long-term orders with any of our significant customers or distributors. Generally we sell products pursuant to purchase orders. In addition, our distributors carry competing product lines which they may promote over our products. A distributor may not continue to purchase our products or market them effectively. Moreover, certain of our contracts with our distributors contain “most favored nation” pricing provisions which mandate that we offer our products to these customers at the lowest price offered to other similarly situated customers. Our operating results could be adversely affected if any of the following factors were to occur relating to one or more of our significant resellers:

	•		the reduction, delay or cancellation of orders or the return of a significant amount of products;
	•		the loss of one or more of such resellers; or
	•		any financial difficulties of those resellers that result in their inability to pay amounts owed to us.

  There are substantial risks associated with the acquisition of NSM Storage GmbH.

     We acquired NSM Storage GmbH in July 2001, which we renamed DISC, GmbH. If we are not successful in integrating its products, services, technology and operations with ours, including coordinating our research development and sales and marketing efforts, the net sales and operating results of the combined company could decline. During the integration of NSM, our financial performance will be subject to risks commonly associated with an acquisition, including the financial impact of expenses necessary to realize benefits from the acquisition and the potential for disruption of operations, including the diversion of management’s attention. We will face difficulties integrating personnel with disparate backgrounds and combining corporate cultures, and we may lose key employees. We may also lose customers and potential customers of NSM in connection with the transition of ownership or otherwise.

     In addition, in connection with the acquisition of DISC GmbH, we assumed debt payable to financial institutions. To the extent DISC GmbH does not generate sufficient cash flow to meet its working capital requirements and such working capital is not available from other sources, our operations may be curtailed or otherwise adversely impacted.

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     The market for DISC GmbH products may not materialize or be of sufficient size to enable us to recover our investment, resulting in the impairment of goodwill, intangible or other long lived assets. Moreover, we may not be able to accurately predict a potential impairment of the goodwill resulting from the acquisition or of the identified intangible assets, which could require us to write-off a significant portion of the goodwill or the identified intangible assets, thereby adversely affecting our operating results.

  Our stock price may be extremely volatile.

     The market price of our common stock has experienced fluctuations and is likely to fluctuate significantly in the future. Our stock price can fluctuate for a number of reasons, including:

	•		announcements about us or our competitors;
	•		quarterly variations in operating results;
	•		the introduction of new technologies or products;
	•		changes in product pricing policies by us or our competitors;
	•		comments regarding us and the data storage market made on Internet bulletin boards; and
	•		changes in earnings estimates by analysts or changes in accounting policies.

     In addition, stock markets have experienced extreme price and volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated or disproportionate to the operating performance of the specific companies. In addition, the securities of many high technology companies, including our securities, have historically been subject to extensive price and volume fluctuations that may affect the market price of their common stock. These broad market fluctuations may adversely affect the market price of our common stock.

  Competition in the computer information storage market may lead to reduced market share, declining prices and reduced profits.

     The markets for data storage solutions are intensely competitive, fragmented and characterized by rapidly changing technology and evolving standards. These conditions could render our products less competitive or obsolete and could harm our business, financial condition and ability to market our products. Some of our competitors have significantly more financial, technical, manufacturing, marketing and other resources than we have. As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer requirements. Competitors may develop products and technologies that are less expensive or technologically superior to our products. In addition, our competitors may manufacture and market their products more successfully than we do our products. Competition from computer companies and others diversifying into the field is expected to increase as the market develops. We may face substantial competition from new entrants in the industry and from established and emerging companies in related industries. There is significant price competition in the markets in which we compete, and we believe that pricing pressures are likely to continue. Certain competitors may reduce prices in order to preserve or gain market share. This pricing pressure could result in significant price erosion, reduced gross profit margins and loss of market share, any of which could negatively affect our business, financial condition and operating results.

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  The storage device market is characterized by rapid technological evolution, and our success depends on our ability to develop new products.

     The market for our products is characterized by rapidly changing technology and evolving industry standards and is highly competitive with respect to timely innovation. At this time, the data storage market is particularly subject to change with the emergence of Fibre Channel protocol and new storage solutions such as storage area networks and network attached storage devices. The introduction of new products embodying new or alternative technology or the emergence of new industry standards could render our existing products obsolete or unmarketable. Our future success will depend in part on our ability to anticipate changes in technology, to gain access to such technology for incorporation into our products and to develop new and enhanced products on a timely and cost-effective basis. Risks inherent in the development and introduction of new products include:

	•		the difficulty in forecasting customer demand accurately;
	•		the possibility that sales of new products may cannibalize sales of our current products;
	•		delays in our initial shipments of new products;
	•		competitors’ responses to our introduction of new products; and
	•		the desire by customers to evaluate new products for longer periods of time before making a purchase decision.

     In addition, we must be able to maintain the compatibility of our products with significant future device technologies, and we must rely on producers of new device technologies to achieve and sustain market acceptance of those technologies. Development schedules for high-technology products are subject to uncertainty, and we may not meet our product development schedules. We have in the past experienced delays in the introduction of some new products. If we are unable, for technological or other reasons, to develop products in a timely manner or if the products or product enhancements that we develop do not achieve market acceptance, our business will be harmed.

  A failure to develop and maintain propriety technology will negatively affect our business.

     Because our business depends on technology, our ability to compete effectively depends in part on our ability to develop and maintain proprietary aspects of our technology. We hold United States and German patents covering various aspects of our technology, including the overall system design of our products. These patents expire between 2007 and 2014. We cannot be certain that these patents will provide meaningful protection for our product innovations. We also rely on a combination of copyright, trademark, trade secret and other intellectual property laws and various contract rights to protect our proprietary rights. Such rights, however, may not preclude competitors from developing products that are substantially equivalent or superior to our products. There can be no assurance that our proprietary technology will remain a trade secret or that others will not develop a similar technology and use that technology to compete with us. In addition, many aspects of our products are not subject to intellectual property protection and can therefore be reproduced by our competitors.

     While we are not currently engaged in any intellectual property litigation or proceedings, we may become so involved in the future. However, there can be no assurance that such claims will not be made in the future. An adverse outcome in litigation could subject us to significant liabilities to third parties, require

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us to license technology from others or require us to cease marketing or using certain products, any of which could negatively affect our business, financial condition and operating results. If we are required to seek licenses under patents or proprietary rights of others, we may not be able to acquire these licenses on acceptable terms, if at all. In addition, the cost of responding to an intellectual property infringement claim, in terms of legal fees and expenses and the diversion of management resources, whether or not the claim is valid, could harm our business, financial condition and operating results.

  Concentration of ownership among our existing executive officers, directors and principal shareholders may prevent other investors from influencing significant corporate decisions.

     As of June 30, 2002, our executive officers, directors and principal shareholders beneficially owned, in the aggregate, approximately 89% of our outstanding common stock, preferred stock and warrants, on an as-if-converted basis. In particular, our largest investor beneficially owns approximately 88% of our outstanding common stock, preferred stock and warrants, on an as-converted basis. As a result, these shareholders, if acting together, will be able to exercise control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership could disadvantage other shareholders with interests different from those of our officers, directors and principal shareholders. For example, our officers, directors and principal shareholders could delay or prevent an acquisition or merger even if the transaction would benefit other shareholders.

  Because we are dependent on international sales for a substantial amount of our net revenues, we face the risks of international business and associated currency fluctuations, which might adversely affect our operating results.

     We expect that international revenues will continue to represent a significant portion of our net revenues in the foreseeable future. Doing business internationally involves greater expenses and many additional risks. For example, because the products we sell abroad and the products and services we buy abroad are priced in foreign currencies, we may be affected by fluctuating exchange rates. We might not successfully protect ourselves against currency rate fluctuations, and our financial performance could be harmed as a result. In addition, we face other risks of doing business internationally, including:

	•		unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
	•		reduced protection for intellectual property rights in some countries;
	•		differing labor regulations;
	•		compliance with a wide variety of complex regulatory requirements;
	•		changes in a country’s or region’s political or economic conditions;
	•		greater difficulty in staffing and managing foreign operations; and
	•		increased financial accounting and reporting burdens and complexities.

     Our international operations require significant attention from our management and substantial financial resources. We do not know whether our investments in other countries will produce desired levels of net revenues or profitability.

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  Downturns in the computer information storage market and related markets may decrease our revenues and margins.

     The market for our products depends on economic conditions affecting the broader information technology and related markets. Downturns in these markets may cause our customers to delay or cancel information technology projects, reduce their information technology budgets or reduce or cancel orders for our products. In this environment, customers may experience financial difficulty, cease operations or fail to budget for the purchase of our products. This, in turn, may lead to longer sales cycles, delays in payment and collection, and price pressures, causing us to realize lower revenues and margins. A prolonged economic downturn would also increase our exposure to credit risk on trade receivables. In particular, capital spending in the information technology sector generally has decreased in the past 12 months, and many of our customers and potential customers have experienced declines in their revenues and operations. If capital spending in our markets continues to decline or does not increase, it may be necessary for us to gain significant market share from our competitors in order to achieve our financial goals and achieve profitability.

  Undetected software or hardware errors could increase our costs and reduce our revenue.

     We may not be able to adequately control and eliminate manufacturing flaws. If flaws in design, production, assembly or testing were to occur in our products or those of our vendors, we could experience a rate of failure in our products that would result in substantial repair or replacement costs and potential damage to our reputation. Continued improvement in manufacturing capabilities and control of material and manufacturing quality and costs are critical factors in our future growth. We cannot assure you that our efforts to monitor, develop and implement appropriate test and manufacturing processes for our products will be sufficient to permit us to avoid a rate of failure in our products that results in substantial shipment delays, significant repair or replacement costs and damage to our reputation. In addition, our products are combined with products from other vendors. As a result, when problems occur, it is difficult to identify the source of the problem. These problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.

  We may be sued by our customers for product liability claims as a result of failures in our data storage products.

     We face potential liability for performance problems of our products because our end users employ our storage technologies for the storage and backup of important data. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.

  A number of key personnel are critical to the success of our business.

     Our future success depends in large part on our ability to retain certain key executives and other personnel, some of whom have been instrumental in establishing and maintaining strategic relationships with key suppliers and customers. Our future growth and success will depend in large part on our ability to hire, motivate and retain highly qualified management, technical, operations and sales and marketing personnel. Competition for such personnel is intense in the high-technology industry, particularly in the San Francisco Bay area. We may not be able to retain our existing personnel or attract additional qualified personnel in the future. In addition, companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We may receive such claims in the future

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as we seek to hire qualified personnel, and such claims could result in litigation. Regardless of the merits of these claims, we could incur substantial costs in defending ourselves against these claims.

  If our securities are delisted from Nasdaq, the trading market and prices of our securities would be harmed.

     The trading of our common stock on the Nasdaq SmallCap Market is conditioned upon our meeting certain asset, revenues and stock price tests. If we fail any of these tests, our common stock may be delisted from trading on the Nasdaq system, which could materially adversely affect the trading market and prices for those securities. In addition, low price stocks are subject to additional risks including additional state regulatory requirements and the potential loss of effective trading markets.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We are not exposed to significant market risk related to fluctuations in interest rates related to interest income, because we are not expected to have significant investments in fiscal 2002. In addition, we do not use derivative financial instruments of any kind.

     We are exposed to short-term fluctuations in interest rates as our borrowings on our lines of credit have variable interest rates. A sharp increase in interest rates would have an adverse impact on our interest expense.

     International sales are made mostly from our German subsidiary and have historically typically been denominated in German Marks, and beginning January 1, 2002 are typically denominated in Euro. Our German subsidiary also incurs most of its expenses in the local currency, the Euro. Accordingly, our foreign subsidiary uses its local currency as its functional currency.

     Our international business is subject to risks typical of an international business including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors. We are also exposed to foreign exchange rate fluctuations as the financial results of our foreign subsidiaries are translated into United States Dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected performance.

     We plan to assess the need to enter into foreign currency exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities, primarily denominated in Euro. We also plan to assess the need to periodically hedge anticipated transactions.

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PART II — OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

     As more fully discussed in Note 3 to the Condensed Notes to the Condensed consolidated Financial Statements, we have issued preferred stock during the second quarter of the fiscal year ended June 30, 2002. The preferred stock has certain rights, privileges and preferences (including liquidation preferences) over our common stock.

Item 4. Submission of Matters to a Vote of Security Holders

     No matters were submitted to a vote of our security holders during the quarter ended June 30, 2002.

Item 5. Other Matters

     We currently engage PricewaterhouseCoopers LLP (“PWC”) as our independent accountants. In addition to the audit services they provide with respect to our annual audited consolidated financial statements included in our Annual Reports on Form 10-K and certain other filings with the Securities and Exchange Commission, PWC has provided us in the past tax compliance services. In accordance with Section 10(A)(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, the Company is responsible for listing the non-audit services approved by the audit committee of our Board of Directors to be performed by PWC. Accordingly, our Audit Committee will be responsible for approving certain non-audit services to be performed by PWC, our independent accountants. These services could relate to consultation, advice and other services in connection with tax planning and compliance, SEC registration statements, potential acquisitions and other transactions, application of generally accepted accounting principles and the provision of statutory audit services in foreign jurisdictions.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits.

	(b)		Reports on Form 8-K
			We did not file any reports on Form 8-K during the quarter ended June 30, 2002.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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INDEX TO EXHIBITS